China’s Plugging of Corporate Information Sieve: Why it Matters

China has closed the gate on access to a wide array of information on Chinese companies – closely held, publicly traded and state-owned – that was once publicly available.

Curiously, before the crackdown, there was more information available on private companies in China than perhaps anywhere else in the world.

Is this a cause of concern? Most emphatically yes.

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China State Administration for Industry and Commerce

No longer so forthcoming.

In common law countries like the U.S., there is very little publicly available information about closely-held companies. Beyond registering a name and address with the state which then bestows the right to incorporate, a private company is typically not required to disclose information about what it does, who owns it, or how it has performed. In civil law countries – like China – companies are listed on a public registry which might require more information, such as a list of directors, but even then financial disclosures are unusual.

China is unusual, not only because financial information is available, but because you never know just what you might find in company files.

Financial information on private companies is collected by the State Administration of Industry and Commerce, but not every company has the same breadth of documents on file with SAIC. In some cases – one in five by one lawyer’s estimate – searches turn up a veritable treasure trove of original documents that can include everything from articles of incorporation and minutes from board meetings to records of assets transfers and changes in shareholders.

The big question surrounding the current crackdown: If other economies function well enough without such information being available, why should China be held to a different standard?

In Western countries, if something goes wrong with a deal or an investment or a joint venture, the parties involved can turn to a fair and transparent legal system that can force the handing over of internal documents. In China, courts are seldom sympathetic to foreigners and their decisions are heavily influenced by local political and economic considerations. Investors here long ago learnt that it is necessary to do extensive due diligence in advance of any deal to avoid being stuck with a nasty surprise in the future.

SAIC filings made a splash in capital markets late in 2010 when short-sellers started citing financial information contained in them as evidence that Chinese firms listed in the U.S. were lying to investors. SAIC figures often showed profit and revenue levels at a mere fraction of what companies were disclosing to U.S. exchanges.

Still, lawyers and investigators say there is little to suggest that the SAIC filings are any more accurate than what’s filed in the U.S. Analysts say Chinese companies typically keep multiple sets of books, and that the numbers they present to the government typically low-ball earnings in an effort to minimize taxes.

People who use SAIC data say its real value lies in helping determine exactly who has an interest in a company, and whether it’s involved in related party transactions – or in the words of one investor, working out who they’re getting into bed with. And that’s of value to private equity investors, companies looking for partners or acquisition targets in China, and even foreign companies wishing to do a background check on potential suppliers.

Often SAIC documents have been only the first step of the investigation process. Until recently China has been a sieve of private data with information on vehicle registration, household residency, phone records and even bank account details available to those who knew who to call. Research companies say that such information has become all but impossible to access since April 20, when the Public Security Bureau launched a nationwide campaign against investigations companies.

According to an April 28 story on the front page of the People’s Daily, the Communist Party’s mouthpiece, the campaign was aimed at protecting people’s privacy, and guarding them – amongst other things – against the nuisance of receiving multiple calls daily on their mobile phones from firms spruikingtheir services. It said that more than 1900 people had been detained.

“In recent years, with the fast development of China’s economy… crimes involving the abuse of citizens’ private information have been on the rise, and the illegal trade of personal information on the internet has spread unchecked,” the Public Security Bureau said on April 24 in a statement and its Web site (in Chinese). “There’s been a proliferation of phone fraud, extortion, kidnapping, and illegal debt collecting…presenting a serious threat to society.”

Still, people in the industry say the campaign is also affecting the use of private information to investigate companies.

Why the government has decided to clamp down on the availability of corporate information is still an open question. Most people affected by the change suspect it’s been prompted by the use of SAIC documents by short-sellers to expose fraud at Chinese companies, which caused the Chinese government quite some embarrassment last year. Others suspect it might be to shield the business interests of government officials from prying eyes, after public documents in Hong Kong were used by some mediaoutlets to track the business connections of Bo Xilai’s family.

Either way, the losers of all this are likely to be investors who used SAIC documents to help light their way through the notoriously murky world of private business in China.

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